Real property valuation Valuation Methods Valuation Theory Value

Real property valuation Valuation Methods Valuation Theory Value Theory Valuation is both a Science and an Art! SWEDESURVEY

Value theory Platon (427 – 347 BC) - division of labour (specialization) contributes to higher efficiency (The State) Aristoteles (384 – 322 BC) - on exchange, money, prices and value (Politics and Ethics) Adam Smith (1723 – 1790) - distinction between Utility value and Exchange value (An inquiry into the nature and causes of the wealth of nations, 1776) SWEDESURVEY

Value theory Karl Marx (1818 – 1883) - connections to Aristoteles and the distinction between utility value and exchange value. The latter is a reflection of the labour which is spent on the specific commodity Marx claimed. (Das Kapital, 1867, 1885, 1894) Hernando de Soto (1940 - ) - on the causes to wealth differences in the world and why capitalism triumphs in the west but fails everywhere else. (The Mystery of Capital, 2000) SWEDESURVEY

Value theory Background factors: The Swedish Hand-book Fastighetsvärdering (Real Estate Valuation): - Utility/Benefit Scarcity Need Use/disposition rights - Transfer rights SWEDESURVEY

Value theory Background factors: The Appraisal of Real Estate Part I, Chapter 2 page 19: - Utility/Benefit - Scarcity - Desire - Effective purchase power SWEDESURVEY

Value theory Background factors - a summary: - Utility/Benefit Scarcity Desire/Need Effective purchase power - Use/disposition rights - Transfer rights SWEDESURVEY

Value theory - Utility/Benefit Scarcity Desire/Need Effective purchase power - Use/disposition rights - Transfer rights The first two factors are related to the supply side of economy and human behaviour, the two next to the demand side of economy and human behaviour SWEDESURVEY

Value Theory • A consequence of: – Valuation factors for real property – – – Social ideals and standards Economic activities and trends Government regulations and activities Physical or environmental forces Location factors • Depends on people´s desires • Depends on future benefits • The value can not be calculated, it can only be estimated SWEDESURVEY

Real property valuation Valuation is both a Science and an Art! Valuation includes components and knowledge of: -mathematics -statistics -physical (land) planning -urban planning -rural planning/agriculture -building construction -sociology/human behaviour -common sense/feeling SWEDESURVEY

Real property valuation Literature: - Handouts - The Appraisal of Real Estate: Part 1 Fundamentals Chapter 2 The Nature of Value (pages 19 – 31) SWEDESURVEY

Real property valuation Valuation Methods Valuation Theory Value Theory Valuation is both a Science and an Art! SWEDESURVEY

Valuation theory Aristoteles (322 -284 BC) - subjective utility value Adam Smith (1723 -1790) - utility value, exchange value David Ricardo (1772 -1823) Thomas Malthus (1766 -1834) SWEDESURVEY

Relation between subjective yield value and market value Seller Buyer´s yield value Area for presumptive transaction Seller´s yield value SWEDESURVEY

Valuation theory Classical scholars: -Smith -Ricardo -Malthus Their basic theory was a sort of “price theory” where they emphasized the influence of production costs on the value but where the demand factor was supressed. SWEDESURVEY

Valuation theory The classical scholars could not sufficiently explain many valuation problems and the Neo-classical appeared: scholars Stanley Jevons (1835 - 1882) Leon Walras (1834 - 1910) Alfred Marshall (1842 - 1924) Ernst Laur (1871 - 1964) The most prominent feature of their ideas were “The margin theory” (Margin utility, margin cost and margin income) The demand component was important for the value, not only the production cost SWEDESURVEY

Valuation theory Modern economists with influence on value theory and valuation theory are: Frederic Babcock (The Valuation of Real Estate, 1932) Richard Ratcliff (Modern Real Estate Valuation, Theory and Application, 1968) SWEDESURVEY

Valuation Theory • Market value – The most probable price of a property on the open market – Used in most cases • Net income value – The present value of future yearly net income – Used e. g. for - investment decisions - market simulation • Cost value – Replacement costs minus depreciation – Used e. g. for - insurance compensation - market simulation SWEDESURVEY

Valuation methods Price = Value = Cost (The Appraisal of Real Estate, 12 th edition, Chapter 2 page 19 -20) SWEDESURVEY

Definition of market value (1) Number of transfers Price Market value The most probable price of the property on the open market SWEDESURVEY

Definition of market value (2) Assdderqw rsdf r r w w wf w h tjh eyh h rt t er rtyr r rth dr - - Market value definition: Some key elements: “ asset” “ the estimated amount” “ a property should exchange” “ on date of valuation” “ between a willing buyer” “ a willing seller” “ in an arm´s-length transaction” “ after proper marketing” “ wherein the parties had each acted knowledgeably” “ and without compulsion” SWEDESURVEY

Valuation Methods • Sales comparison approach • Income capitalisation approach • Cost approach When searching for a market value, the income and cost methods are market simulating methods! SWEDESURVEY

Sales comparison approach • Identification and selection of real properties purchased in a comparable market area • Objects are made comparable. . . • . . . and adjusted according to purchase dates (price trends) or other differencies • Mean price of the selected purchases = estimated market value SWEDESURVEY

Information needed • Information about the purchase Seller: Mr Ek – Price Buyer: Mrs Alm Date: 04 -09 -15 Price: 1 200 000 – Date of sale etc. – Seller – Buyer • Information about the real property – Land use – Land area – Building: size, age, standard etc. – Other special conditions SWEDESURVEY

Income capitalisation approach (1) SEK/ USD Remaining value Yearly net income 0 1 2 3 etc. . n Year The current value of future yearly net income and remaining value at the end of the calculation period SWEDESURVEY

Income capitalisation approach (2) 4 methods: • Sales price / square meter • Sales price coefficient • Gross capitalisation factor • Net capitalisation percent SWEDESURVEY

Information needed • Information about the real property: – – – Land use Land area Building: size, age, standard etc. Yearly costs and incomes Other special conditions SWEDESURVEY

The cost approach SEK/ USD Replacement costs Depreciation 3. 5 %/year Cost value Cost of land 0 10 Replacement costs Depreciation 10 years 3, 5 % Cost of land Cost value Age (years) 1 000 - 350 200 850 SWEDESURVEY

Information needed • General information – Average replacement costs – Depreciation - time and percent – Average value of land • Information about the real property – Land use – Land area – Building: size, age, standard etc. – Other special conditions SWEDESURVEY

Real property valuation Notice - a frequent mistake ! Economics Mathematics Statistics GIS Land planning Sociology Common sense Others SWEDESURVEY

Real property valuation Recommendation - a balanced and appetizing mix ! Economics Mathematics Statistics GIS Others Land planning Sociology Common sense SWEDESURVEY